ACCT 436 INTERNAL AUDITINGEXAM 3

QUESTION

ACCT 436 INTERNAL AUDITINGEXAM 3

INSTRUCTIONS

You
are allowed to use any of the course materials.
Make sure you take your time and provide complete answers. Two or three
sentence answers to any of these questions will not be adequate! Your logic,
thought processes and quality of your responses are what will determine your
grade.Questions 1-2 are worth 15 points.
Questions 3-4 are worth 10 points each.
Please submit your responses in a Word document. Be sure to put your name on each page. Good luck!

1)ABCs capital-asset procurement policy
requires the Board of CAEs (BOD) approve any single acquisition over $150,000. If
the board approves a project, then the treasurer will transfer the funds to the
respective plant. Within one year, the internal auditing function is charged
with reviewing each acquisition to check the propriety of the purchase and
disbursal of funds.

ABCs
Plant Controller prepared the first proposal for a DEK cutting machine. Other
plants were told to wait until internal auditing could inspect the
documentation associated with the acquisition, and evaluate the projects
operating effectiveness and efficiency. The plants proposal was the second
largest proposal ever submitted in the companys history and it totaled $1.3
million dollars. The cost of the new machine by itself was listed in the
proposal at $1.1 million. Labor and other costs necessary to remove the old
machine and install the new machine totaled $200,000.

The
internal auditor assigned to the investigation was Phil Ramone. Phil had been
with ABC four years performing mostly production operational audits (on
existing processes) and internal control payroll audits. Phils considerable
experience in these areas led him to believe that the procedures associated with
this capital-asset audit would be as simple and routine. This was not Phils
first visit to the plant. In fact Phil had performed an audit on the plants
payroll system only a year ago. Phils recollection of the experience was not a
pleasant one. He had several confrontations with the plant controller, mostly
as a result of personality clashes. While all the payroll issues were easily
resolved, Phil felt there was still an adversarial relationship between him and
the controller and was on guard for any preemptive strikes this time around by
the controller.

It
was a long drive to the plant so when Phil
arrived a little late the day of his audit he was greeted by the controller
with a perceived air of indifference and promptly led to a secluded office. The
controller calmly explained that he was extremely busy and would answer any
questions at the end of the day. Phil merely nodded his head and sat down in
front of several tall piles of invoices, which the controller stated was the
documentation supporting the purchase, set up, and testing of the new machine. Phil
was somewhat surprised, fully expecting to see only a handful of invoices, but
did not ask for any explanations. As Phil began looking through the myriad of
statements and canceled checks he soon found one particular invoice near the
top of the first pile that indicated the actual price paid for the machine
itself was only $850,000.

Phils
first reaction was to call the CAE of auditing. When he found that the CAE was
out for the day and could not be reached he then decided to call the VP of
Operations at corporate headquarters. Phil was critical of the plant controller
when describing the seriousness of his suspicions based on this preliminary
information. Phil didnt know that there was a BOD meeting that day and that
the news would be passed on to them. The members of the Board were outraged, screaming
over the alleged misuse of the funds and possible fraud.

ACCT 436
INTERNAL AUDITINGEXAM 3

Phil was
unaware that in a private conference call the Chair of the Board of CAEs would
soon lambast the plant controller. Seconds after the call, the controller
walked up to Phil and had only two words to say “ œget out. Phil was
flabbergasted; he called back to headquarters, only to receive a rather icy
response from the Chair of the BODs secretary suggesting that he return
immediately.

Three
days later Phil was called in to the CAEs office. The CAE described how he
personally went to the plant the next
day after Phils visit and performed the capital-asset audit himself. The CAE
found that there were a number of reasonable explanations for the differences
between the original proposal and the actual expenditure. To begin with, the
company that sold the machine would not discount the price until the BOD
approved the contract. Competing bids
drove the cost of the machine from $1.1 million to $850,000. However, there
were several factors that offset these savings.

Originally,
the setup of the new machine was projected to take a week and a half but ended
up taking a month. No one really knew how difficult it was going to be to
remove the old machine that was embedded in the concrete floor (to minimize
vibration). This removal took additional time and outside labor. Also, the new
machine was to be put in the same area where the old machine was located. Since
the plant could not afford to shut down for any extended length of time, the
old machine was moved over the Thanksgiving Day holiday when labor rates were
doubled. In addition, while the new machine was being tested, the old machine
had to be kept running in its temporary location. During the time that both
machines were running, machine operators and supporting personnel (e.g., those
loading and unloading the conveyors) worked double shifts in order to test the
new machine. This parallel process took longer than expected because the plant engineers were not familiar enough with
the new machine to deal with minor problems. Also, special outside consultants
were hired for the first two weeks to set up the machine.

Another
unexpected cost arose because the new machine put out a greater number of
larger pieces of wood requiring required an additional conveyor belt to accept
and carry the larger pieces. The savings from the discount was used to purchase
this necessary piece of equipment. In sum, all of these additional and
unexpected outlays were very expensive and brought the total to just under the
original proposed cost of $1.1 million.

The
CAE went on to explain to Phil that the reason for the abnormally large number
of invoices was an endless stream of trips to the local electrical and hardware
stores to buy the necessary parts and supplies to keep the transition from the
old to the new machine moving smoothly. As it turned out, the Controller of the plant actually did a commendable job in
overseeing the project and keeping accurate records of the disbursements. In
fact, the controller created a specialized installation guide that will
probably save ABC hundreds of thousands of dollars when the remaining plants
order more of these machines.

Required

1.
Comment
on Phils preparation for and conduct of the audit. What should Phil have done
differently?

2.
Discuss
the possible violations of the IIA Code of Ethics and/or International
Standards for the Professional Practice of Internal Auditing that Phil committed.

ACCT 436
INTERNAL AUDITINGEXAM 3

2)Recently, several states have
outsourced some of the services traditionally provided by government employees.
In one state, the Department of Health and Human Services (Department) has
outsourced its electronic benefit transfer services to eFunds Inc. Under the
contract, eFunds Inc. handles the electronic distribution of food stamp
programs, including transaction processing, reporting, contract management,
contract settlement, operations support, help desk services, and project
management. For cost reasons, eFunds Inc. sent the work to five offshore
service centers it owns in India.

a) Describe
the three most significant risks that this offshore outsourcing arrangement
introduces to the states Department of Health and Human Services.

b) What are
the key controls you would recommend to mitigate the risks cited in part a.

c) What role
should the Departments internal audit function take to assist the Department
in dealing with these risk and control issues?
Be specific.

3)
On March 4, 2013 the NASDAQ Stock Market LLC filed a proposed rule
change that would require listed companies to establish and maintain an
internal audit function. Specifically:

Each
Company must establish and maintain an internal audit function to provide
management and the audit committee with ongoing assessments of the Companys
risk management processes and system of internal control. The Company may
choose to outsource this function to a third party service provider other than
its independent auditor. The audit committee must meet periodically with the
internal auditors (or other personnel responsible for this function) and assist
the Board in its oversight of the performance of this function. The audit
committee should also discuss with the outside auditor the responsibilities,
budget and staffing of the internal audit function.

Some of these comments supported the rule
change but a significant number, particularly from smaller companies, argued
against the change. A common theme of those against the change is
reflected in the following from the CFO of Perceptron, Inc.:

There already exists a requirement for
public companies to review, maintain and report on internal controls under
Federal securities law. Rules 13a-15 and 15d-15 specifically require a certification
by the Chief Executive Officer and the Chief Financial Officer. This proposed
rule by NASDAQ adds a second layer of regulation that is not necessary and
would not provide value. Perceptron maintains internal controls with management
oversight and already engages outside, independent firms to perform SOX 404
testing of its internal controls. Management provides a report of the results
of its independent firms testing every quarter to the Audit Committee.
Further, the Companys independent auditor meets with the Audit Committee
regularly, including in private sessions without managements presence.

Most
companies listed on NASDAQ have an internal auditing function. However
according to an article by Richard Chambers, œ.navigant.com/services/financial_advisory/financial-risk-management/”>research
by the consulting firm Navigantindicates that 40
percent of NASDAQ-listed companies with market capitalization between US $75
million and US $250 million do not have internal audit functions. Chambers, R. (2013, June 3). NASDAQ
Hesitates in Its Quest to Mandate Internal Audit. Retrieved July 30, 2015.

Ultimately
NASDAQ withdrew the proposed rule. If
you agree with the logic of the critics of the proposed rule, explain how SOX
404 and CEO/CFO certification removes the need for an internal audit function.
If you dont agree with the critics as well as the decision of NASDAQ, explain
what an internal audit function adds beyond SOX 404 and CEO/CFO certification.

ACCT 436
INTERNAL AUDITINGEXAM 3

4)a) When
and in what ways do audit engagement communications occur?
b)
What actions regarding audit engagement observations must the internal
audit function take after the final engagement communication is
disseminated?

ANSWER

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